Financial Markets Seem Disinterested in Debt Discord

July 10, 2011

Jim Zarroli

Washington may be preoccupied with the debate over whether to raise the debt ceiling and the consequences of a default, but so far at least, the nation's financial markets seem to be taking the prospect in stride.

Although politicians from President Obama on down have been predicting for weeks that a debt default would wreak havoc on the global economy, interest rates on U.S. government debt remain near historic lows.

The 10-year Treasury bill, often seen as a barometer of investor sentiment toward the bond market, hovered around 3 percent on Friday.

An Economic Disaster

Most economists believe that a failure to raise the debt ceiling would be a catastrophe for the global economy, particularly if it drags on. The federal government would no longer have the money to pay its bills, and would be forced to choose between writing checks for expenditures like Social Security and making good on its obligations to bondholders.

The mere prospect that the U.S. might default on its debts would scare investors and force them to look for alternative places to stash their money, says John Canavan, who analyzes the bond markets for Stone and McCarthy.

"A lot of money that would typically flow into Treasuries in times of uncertainty would be more likely to flow into Bunds in particular. That is, German debt markets," he says.

With money no longer flowing into the Treasury markets, the U.S. government would have to pay more to borrow what it needs, driving up interest rates for mortgages, business loans and other kinds of credit.

Investors Stay Put

The fact that nothing like that has happened so far means investors are sticking with U.S. Treasury debt. That suggests that many investors believe the debt-ceiling debate will be resolved before Aug. 2, when the federal government is expected to run out of money.

Jim Paulsen, chief investment strategist at Wells Capital Management, sees the controversy as little more than political theatrics, and says it's virtually certain that the White House and members of Congress will end the impasse before it's too late.

"The reality is not a one of them is going to allow an effective and meaningful default by the U.S. government," Paulsen says.

"Right now it seems like the markets, as well as myself, believe that the government is going to come to its sense and come up with some plan at the last minute," says Beth Ann Bovino, senior economist at Standard and Poor's.

"Certainly, politicians like to (show) bravado, so it's probably going to happen at the last minute, just like a Hollywood blockbuster," she adds.

Other, Bigger Worries

But there may be another reason interest rates remain so low.

Simply put, the financial markets have a lot on their plates right now. The European debt crisis, the surge in energy prices and the continued weakness in the employment market are all threatening economic growth.

"There has been some indication of a little bit of nervousness but as far as the treasury markets are concerned, there have been more pressing, near-term concerns," Canavan says.

These troubles are forcing investors to look for other places to stash their money. For all the problems facing the domestic economy right now, the Treasury markets are still seen as among the safest and most liquid in the world, Bovino says.

The QE2 Sets Sail

Not even the end of the Federal Reserve's so-called QE2 program has ruffled the markets.

Under the program, the Fed purchased $600 billion in long-term Treasury bills as a way of pouring money into the economy and bringing down interest rates.

When Fed officials announced they would let the program expire on June 30, there were predictions it would push rates back up.